The RBA announces its decision on interest rates today. Will the bank cut the cash rate from 4.25% to 4.00%?

That’s an interesting question. But is it relevant? ANZ is just one of the Australian banks to go on record and say that the RBA’s price of money isn’t what ANZ pays. See the 12 December 2011 Daily Reckoning for more on this. This is the banks’ way of saying they’re not obliged to match the RBA’s rate cuts point for point.

It’s kind of quaint to think there are some people in Australia who think the RBA actually controls the price of money. But some people do! Take Ged Kearney for example. He’s the president of the Australian Council for Trade Unions (ACTU). Kearney told the Herald Sun…

Last year the big four banks made profits of $25.2 billion – easily more than the rest of the banking sector combined. They now have a greater share of the home lending market than before the global financial crisis….If the banks cannot behave in a socially responsible manner, it may be time to consider stronger government regulation to drive greater competition, improved consumer protection and more sustainable corporate behaviour in the banking sector.

Heaven forbid that we’d defend the banks in this space. But someone might want to tell Mr Kearney that Moody’s has just released a report claiming that Australian banks are the “most exposed” banks in the Asia-Pacific to a worsening of Europe’s sovereign-debt problem. What exactly does that mean?

Before you go bagging out Moody’s for being an unreliable ratings agency that shouldn’t be trusted, consider the main point in the note. Moody’s isn’t worried about the amount of European government debt Australian banks own. That’s not the problem. The problem is that Australian banks get at least 19% of their funding externally.

In a genuine liquidity/credit crisis, external funding a) gets more expensive, b) dries up for all but the highest credit-quality borrowers. The cost of money goes up and there’s less of it to go around, in other words. This is why banking is a lousy business in a credit depression and why bank stocks make lousy investments.

By the way, we’d started to go into detail examining the current situation in Greece and Europe…but to be honest, we just couldn’t bear spending another precious second analysing a situation that’s so hopelessly doomed…and so cynically and horribly mismanaged. As our colleague Dylan Grice at Société Générale writes:

Flawed thinking got us into this mess. But rather than change that flawed thinking, our policy makers are applying it with even more rigour: we have more debt for insolvent borrowers, more financial engineering, more complicated banking regulations, more blaming speculators for everything, more monetary experimentation by central banks. Our policy makers have absolutely no idea what they’re doing, but they’re giving it a go!

Grice refers to the “Lost Pilot Effect”. That’s a term invented by behavioural psychologists to explain a certain kind of irrational behaviour. You see it when a pilot gets lost but tells his passengers, “I have no idea where we’re going…but we’re making good time!”

There’s no point in hurrying along somewhere if you don’t know where you’re going. And it’s even more insane to hurry along to a place where you don’t want to be! The best move, if you’re lost, is to get out a map and a compass and find out exactly where you are.

Hopefully Dylan will bring his map and compass with him to Sydney next month. He’s one of our four keynote speakers at the After America conference. We invited a thoughtful group of keynote speakers for our first conference for a reason. We want you to hear from people who can help will help you figure out where we are on the map.

The particular map we’ll be looking at is the Asia-Pacific region. The main players are China, the United States, and Australia. It’s a big map. It covers a lot of territory. There’s a lot to talk about. But hopefully the conference is small enough – only space for 344 attendees – that we’ll be able to really dig into some of these ideas.

It’s been an eye-opener organising a conference around one big idea. One mistake we realise we made is not giving people enough time to make travel plans and arrangements. We won’t make that one again! In fact we’re already planning next year’s show.

Another concern is location. Up until now, all of our events have been in Melbourne because that’s where we are. We thought an event in Sydney would make it easier for readers in New South Wales and Queensland to attend. Hopefully we can have events in Brisbane, Perth, and Adelaide too. But maybe not this year.

Price is an interesting one. One friend told us that for the line-up we had put together and the small crowd and the number of new ideas from Port Phillip Publishing editors, the price seemed too cheap. Another financial professional told us that when you factored in travel and hotel arrangements, the price was too expensive.

Either way, this is not a money-making venture for us. For five years we’ve been having a conversation with you about Australia’s future. We thought it was high time to set aside a few days, invite some guests, and really talk about it, including some specific ideas. It’s going to be a cracking show.

One of our other keynote speakers is Dr. Paul Monk. Like Dylan, Dr. Monk is interested in how we think, how we make decisions, and the quality of our knowledge. In the article below, he reviews Daniel Kahneman’s latest book on how we think.

The Brain: A machine for jumping to conclusionsBy Paul Monk

Daniel Kahneman’s Thinking, fast and slow should be required reading for everyone this summer. Not because it is entertaining or a mere diversion, but because it is a subtle and beautifully scientific guide for the perplexed. If you see yourself as a citizen in a democratic polity, read this book. Self-indulgent cynics and self-important ideologues probably won’t read it, but they are the ones most in need of what it has to teach. Do yourself a favour, whoever you are: rush out, buy this book and read it quietly and thoughtfully, absorbing its highly readable insights.

Kahneman was awarded the Nobel Memorial Prize in Economic Sciences in 2002 for his work on prospect theory. To understand what is meant by this, how Kahneman got into thinking about it and what his key insights were – in collaboration with his long time research partner Amos Tversky – go straight to chapter 26 ‘Prospect Theory’. It’s a fascinating excursion into clear thinking all on its own. Prospect theory is about gambling, risk-taking and expected returns. It’s a body of theory with considerable practical relevance to the king-sized mess both welfare economics and financial markets got themselves into by the late 2000s.

Kahneman re-examined the fundamentals of utility theory, articulated by Daniel Bernoulli, almost three hundred years ago. He did this long before the past decade or two’s extravagant follies came close to wrecking economies from California to Greece. Utility theory lies at the foundation of modern economics and there is a rather urgent need right now to understand what has gone so awfully wrong in so many economies. Falling back on Marxism or some kind of self-satisfied ideological cliché does not amount to such understanding. Kahneman confers considerable understanding. That’s why he deserved his Nobel Prize.

Thinking, fast and slow has five parts: Two Systems, Heuristics and Biases, Overconfidence, Choices and Two Selves. It also contains, as appendixes, two of the classic papers for which Kahneman won his Nobel: ‘Judgment under Uncertainty’ and ‘Choices, Values and Frames’. Part I sets cognitive science in an easy to understand frame of reference which acts both as a disciplined corrective to a good deal of pop psychology and a lucid introduction to the theoretical work in the following four parts of the book.

He suggests that we think of our brain – our “machine” for making judgments – as consisting of two basic systems; which he calls System 1 and System 2. He describes the characteristics of each and explains how their faults and standard ways of interacting result in many kinds of error, bias and illusion – universally and predictably, not in merely unusual or idiosyncratic cases. System 1 is the intuitive, unconscious, fast reaction part of the brain. It is emotional, holistic and instinctual. It is, as he expresses it, “a machine for jumping to conclusions”.

In certain circumstances and often in everyday life, its functions are reliable, rapid and even remarkable. But when it comes to matters that require complex, abstract thinking it is in deep trouble. System 2 is better equipped – if trained and switched on – to handle such matters. The problem with System 2 is that it is lazy and highly inclined to rationalize rather than critically examine the intuitive judgments of System 1.

In Parts II, III and IV of the book, drawing upon the work of many psychologists and cognitive scientists, Kahneman offers an endlessly fascinating dissection of the brain of Homo sap. The chapters include ‘The Law of Small Numbers’, ‘Anchors’, ‘The Science of Availability’, ‘Availability, Emotion and Risk’, ‘Causes Trump Statistics’, ‘Intuitions vs Formulas’, ‘Risk Policies’ and ‘Frames and Reality’. And at every point Kahneman exhibits a demeanour at once keenly curious, meticulously scientific and utterly unpretentious. The implications of what he imparts are enormous and need to be digested by our education systems (not least all business administration courses), our public policy systems and our methods for public debate.

An indication of the ways in which such insights can be applied was offered several years ago, in Richard Thaler and Cass Sunstein’s Nudge: Improving Decisions About Health, Wealth and Happiness. Originally completed in 2007, it was reissued in 2008 with a Postscript titled ‘The Financial Crisis of 2008′. They drew attention to the alarming reality that almost no economists or financial analysts had foreseen the crisis, or issued public warnings as it approached. They praised the behavioural economist Robert Shiller for having done so.

Shiller’s warning in 2005 had been that “social contagion” was creating a massive housing market bubble that would inevitably burst. Shiller’s books, Irrational Exuberance (2000) and The New Financial Order: Risk in the 21st Century (2003) are recommended reading. Thaler and Sunstein’s own observation is that sound public policy, informed by the insights of cognitive science and behavioural economics, needs to invent ways (they suggest a number) to prevent or defuse such outbreaks of social contagion, or what Charles Mackay long ago called ‘extraordinary popular delusions and the madness of crowds.’

As Michael Lewis’s peerless writing shows, a little thoughtful analysis can reap enormous dividends. If markets and capitalism are to flourish and the costs of human stupidity are to be contained in future, then many things will need to be rethought and reformed. Lewis’s latest book, Boomerang: The Meltdown Tour, a characteristic tour de force shows this from Iceland and Ireland to Greece, Germany and California. If you don’t read Kahneman this summer, you simply must read Lewis.

Kahneman, meanwhile, is hard at work trying to engineer better thinking in the marketplace, or at least to nudge the unwilling and unwitting in that direction. He is a partner in a firm called Greatest Good, committed to applying cutting-edge data analysis and the insights of behavioural economics to real business challenges. His associates are a highly impressive group of people, including Steven Levitt (of Freakonomics fame), innovative economists Gary Becker and John List, the checklist manifesto man Atul Gawande and the brilliant theoretical physicist Lisa Randall. Now that, to paraphrase Groucho Marx, is a club of which I’d like to be a member.

About the author: Dr. Paul Monk has a PhD in international relations from Australian National University. Paul worked for the Australian Department of Defence and the Defence Intelligence Organisation, where he later became head of China analysis and chairman of the inter-agency working group on China. He is a keynote speaker at After America: the Port Phillip Publishing Investment Symposium, March 14th-16th at Sydney’s Intercontinental Hotel.